One ratio that is of particular personal interest to persons that closely examine their finances is the debt-earnings ration, also called the debt-to-income, ratio. Lenders frequently use this ratio to determine whether a potential homebuyer can afford the mortgage on the home he wishes to purchase. You should not only understand how to calculate this ratio, but also the percentages and requirements of interest to lenders.

Calculation

To calculate your debt-to-income ratio, add together all of your monthly debt payments. These include your car payment, monthly balances due on your credit cards, school loan payments, mortgage mortgage payments and other monthly debt payments. Next, add together the gross income you receive each month, which is income before taxes. Income sources include wages, salary and commission from your job, interest and dividend income from investments, rental and royalty income from property you own, Social Security or unemployment compensation, tips and annuity payments. Divide your debts by your income to obtain your ratio, expressed as a percentage.

Meaning

The debt-to-income ratio helps a person to analyze his debt and his ability to repay it with his current income. It is often difficult for a person to significantly change his monthly gross income. Taking on too much debt can make it difficult to afford his current lifestyle and to save for general purposes or retirement. Prior to taking on a mortgage, many lenders examine this ratio to see if the potential borrower can afford the loan.

Lender Requirements

Most lenders calculate your debt-to-income ratio when you seek to take out a mortgage. While the Federal Housing Authority (FHA) has less stringent standards, many lenders do not want your monthly mortgage payment to exceed 28 percent of your gross monthly income. They would also prefer that your total debt payments do not exceed 36 percent of your current gross income. The FHA, however, uses limits of 29 and 41 percent, respectively.

Personal Uses

You can use your debt-to-income ration to see how it will affect taking on other types of debt such as a car payment. Over the course of your lifetime, you should try to decrease this ratio as you pay off the debt to acquire certain assets. Try not to exceed the 36-percent benchmark to ensure that you can afford living expenses and savings. If you are seeking a mortgage, you can use the ratio to ensure that all of your other debt payments do not exceed 8 percent of your gross monthly income.

About the Author

Christine Aldridge is a financial planner who has been writing articles related to personal finance since 2011. She has bachelor's degrees in political science from North Carolina State University and in accounting from University of Phoenix. Aldridge is completing her Certified Financial Planner designation via New York University.